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Cisco CEO John Chambers and CFO Dennis Powell Discuss Q3 Fiscal Year 2004 Results

May 11, 2004

Cisco has announced its Q3, Fiscal Year 2004 financial results. John Chambers, president and CEO, and Dennis Powell, CFO and senior vice president, had the following to say regarding the company's results and business outlook.

How would you characterize this most recent quarter?

More Information

News Release
Cisco Systems Reports Third Quarter Earnings

Related Link
Customer Highlights and Technology Innovations Fact Sheet:Third Quarter, FY 04

Q&A: Dennis Powell On Cisco's Q3 Financial Position

You have set forth three long-term financial priorities, can you provide an update?

Dennis Powell: Cisco's results this quarter are reflective of our continued focus on our three long-term, key financial priorities. First, we continued to generate profitable growth, as evidenced by our increase in revenue of 22 percent year-over-year, and our pro forma profit increasing 26 percent year-over-year and representing 24 percent of revenue. Second, I am pleased with our progress to date on Cisco's productivity, as measured in terms of pro forma operating expense as a percentage of revenue, at 38 percent quarter to quarter. However, we remain committed to our longer term objective to achieve 35 percent of operating expense as a percentage of revenue. Finally we maintained our healthy and conservative balance sheet, and we continue to effectively manage our working capital, helped by our strong cash flow from operations.

GAAP net income increased 67 percent quarter-over-quarter, while pro forma net income was up only 3 percent--why such a large difference between the two?

Dennis Powell: GAAP net income was impacted in Q2FY04, due to an accounting charge related to the acquisition of Andiamo. The $567 million, non-cash variable stock compensation charge was taken at the end of Q2FY04. As a one-time charge, the charge from this accounting change was not included in our Q2 pro forma results, however it impacted Q2 GAAP earnings by $.08 per share, and accounts for a significant portion of the difference between Q3 and Q2 GAAP net income results. This is a good example of why we offer pro forma results as a supplemental measure to provide greater transparency to our financial results.

John Chambers: We are pleased to have achieved record earnings per share this quarter-marking our eighth consecutive quarter with pro forma net income exceeding $1 billion, and the strongest cash flow from operations in the company's history.

We were very pleased with almost all of our operational measurements for the quarter-with a good balance in terms of our focus on profit contribution, net income, gross margins, profitable market share gains, geographic balance, Advanced Technologies and revenue growth. We were pleased with our Q3 revenue results of $5.6 billion, a 4 percent sequential quarter-over-quarter increase and year-over-year product revenue growth of approximately 25 percent. This represents the fourth quarter in a row with a sequential revenue growth. We continue to believe we have uniquely positioned Cisco in the market as the recovery continues to gain momentum on a global basis.

Did you see momentum in your core technologies and Advanced Technology markets?

John Chambers: Our record-setting earnings per share and profits were achieved through sequential order growth across all major product categories and solid progress in our Advanced Technologies including the areas of security, wireless LAN and IP telephony. Order momentum continued to be very strong for our major routing and switching product categories, with year-over-year growth of approximately 80 percent and sequential growth of approximately 13 percent for Advanced Technologies. Additionally, we are beginning to see a very good balance between the enterprise, commercial and service provider market segments in terms of order growth both sequentially and year-over-year.

The top three areas that generated the most interest in our enterprise accounts are security, wireless and IP telephony. This quarter, security revenue rose sequentially in the mid teens and both wireless and IP telephony rose sequentially a little over 20 percent. In the IP telephony area we also shipped our 3 millionth phone. To put this in proper perspective, it took us over 30 months to ship our first million phones, it took approximately 13 months to ship our next million phones, and in the last eight months, we shipped our next million phones.

During this quarter, where did Cisco see geographic strengths?

John Chambers:We were very pleased with the growth that occurred in terms of orders in the US enterprise and commercial market segments. Order growth in these segments represented the first major growth, adjusted for normal seasonality, that we have seen in a very long time with a good balance across all verticals. CEO opinions continue to show increasing optimism toward the economy and toward their own industries and companies. Time will tell if this momentum continues, but we were obviously pleased with this quarter from a US enterprise/commercial perspective.

In EMEA, Cisco saw order growth in the low double digits. In terms of major operations, the UK led the way in terms of sequential order growth in the 20 percent plus range, followed by Northern Europe in the low double digits. There was also solid sequential growth in Germany in the high single digits, which was the best we've seen in terms of sequential growth in over two years.

Japan increased from 7 percent in Q2 to 8 percent of our business, and had very solid sequential order growth of approximately 20 percent. Asia Pacific, represented a 10 percent of our total bookings with a slowing of orders in China, Hong Kong, and Taiwan from a sequential perspective due primarily to seasonal factors, although year-over-year growth in these areas remains solid. We saw good sequential order growth in India and other parts of Asia. In Americas International, after two strong quarters of double digit growth, Q3 growth continued in the high single digits. Canada posted the best sequential order growth rate of the large countries in Americas International, in the high teens.

In the coming year, where do you intend to focus your partnership and investments and acquisition strategies?

John Chambers: In the next year, we expect we will be increasingly active in acquisitions and investments and we will continue to grow our investment in our partners. We've identified a number of existing and adjacent markets that offer strong growth opportunities for Cisco across the service provider, enterprise and consumer markets, that include voice, security and video. Our alliance activity will focus on increasing the adoption of our Advanced Technologies and driving our service provider alliances.

What is your acquisition strategy?

John Chambers: As Dan Scheinman, our senior vice president of Corporate Development said on today's call, Cisco's fundamental acquisition strategy remains unchanged, and we will continue to take strategic risks. First, the ability to integrate and link acquisitions with Cisco's internal innovation and deep customer knowledge allows us to create multiple generations of products and technology leadership, including LAN switching, telephony and security. Second, acquisitions can provide unique ways to support new business models. For example, Linksys allowed Cisco to quickly and successfully enter the consumer market, while supporting a significantly different business model. Finally, we acquire to augment and enhance our current Advanced Technology strategy which includes the following spaces, such as security and IP telephony.

Have your recent acquisitions been successful?

John Chambers:The acquisitions we've made over the past two-and-a-half years have grown at almost 60 percent within the last year, and we believe have solid potential for growth going forward. What has changed recently is that we are seeing high quality teams, at more favorable prices, and at a much stronger point in their development cycle. In all, we expect that we will be busy over the next 12 to 18 months focused on creating more value for Cisco shareholders.


Cisco Systems, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per-share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
May 1, 2004
April 26, 2003
May 1, 2004
April 26, 2003
NET SALES:
Product $ 4,730 $ 3,799 $ 13,543 $ 11,703
Service 890 819 2,576 2,473
Total net sales 5,620 4,618 16,119 14,176
COST OF SALES:
Product 1,452 1,086 4,193 3,467
Service 301 263 855 765
Total cost of sales 1,753 1,349 5,048 4,232
GROSS MARGIN 3,867 3,269 11,071 9,944
OPERATING EXPENSES:
Research and development 801 703 2,295 2,290
Sales and marketing 1,131 1,019 3,295 3,084
General and administrative 215 181 605 504
Payroll tax on stock option exercises 3 - 12 -
Amortization of deferred stock-based compensation 101 25 188 101
Amortization of purchased intangible assets 60 92 182 284
In-process research and development 2 3 3 3
Total operating expenses 2,313 2,023 6,580 6,266
OPERATING INCOME 1,554 1,246 4,491 3,678
Interest Income 127 161 388 514
Other income (loss), net 40 (26) 177 (552)
Interest and other income (loss), net 167 135 565 (38)
INCOME BEFORE PROVISION FOR INCOME TAXES AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE 1,721 1,381 5,056 3,640
Provision for income taxes 510 394 1,468 1,044
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE 1,211 987 3,588 2,596
Cumulative effect of accounting change, net of tax - - (567) -
NET INCOME $ 1,211 $ 987 $ 3,021 $ 2,596
Income per share before cumulative effect of accounting change:
Basic $ 0.18 $ 0.14 $ 0.52 $ 0.36
Diluted $ 0.17 $ 0.14 $ 0.51 $ 0.36
Net income per share:
Basic $ 0.18 $ 0.14 $ 0.44 $ 0.36
Diluted $ 0.17 $ 0.14 $ 0.43 $ 0.36
Shares used in per-share calculation:
Basic 6,816 7,062 6,872 7,165
Diluted 7,074 7,158 7,095 7,257


Cisco Systems, Inc.
PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per-share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
May 1, 2004 April 26, 2003 May 1, 2004 April 26, 2003
NET SALES:
Product $ 4,730 $ 3,799 $ 13,543 $ 11,703
Service 890 819 2,576 2,473
Total net sales 5,620 4,618 16,119 14,176
COST OF SALES:
Product 1,452 1,086 4,193 3,467
Service 301 263 855 765
Total cost of sales 1,753 1,349 5,048 4,232
GROSS MARGIN 3,867 3,269 11,071 9,944
OPERATING EXPENSES:
Research and development 801 703 2,295 2,290
Sales and marketing 1,131 1,019 3,295 3,084
General and administrative 215 181 605 504
Total operating expenses (a) (b) (c) (d) 2,147 1,903 6,195 5,878
OPERATING INCOME (a) (b) (c) (d) 1,720 1,366 4,876 4,066
Interest income 127 161 388 514
Other income (loss), net (e) 40 (26) 92 (140)
Interest and other income (loss), net (e) 167 135 480 374
INCOME BEFORE PROVISION FOR INCOME TAXES (a) (b) (c) (d) (e) 1,887 1,501 5,356 4,440
Provision for income taxes (f) 528 420 1,499 1,242
NET INCOME $ 1,359 $ 1,081 $ 3,857 $ 3,198
Net income per share:
Basic $ 0.20 $ 0.15 $ 0.56 $0.45
Diluted $ 0.19 $ 0.15 $ 0.54 $ 0.44
Shares used in per-share calculation:
Basic 6,816 7,062 6,872 7,165
Diluted 7,074 7,158 7,095 7,257
A reconciliation between net income on a GAAP basis and pro forma net income is as follows:
GAAP net income $ 1,211 $ 987 $ 3,021 $ 2,596
(a) In-process research and development 2 3 3 3
(b) Payroll tax on stock option exercises 3 - 12 -
(c) Amortization of deferred stock-based compensation 101 25 188 101
(d) Amortization of purchased intangible assets 60 92 182 284
(e) (Gain) loss on publicly traded equity securities - - (85) 412
(f) Income tax effect (18) (26) (31) (198)
(g) Cumulative effect of accounting change, net of tax - - 567 -
Pro forma net income $ 1,359 $ 1,081 $ 3,857 $ 3,198

For the three month period ended January 24, 2004, pro forma net income and pro forma net income per share excluded the following items: in-process research and development of $1 million, payroll tax on stock option exercises of $7 million, amortization of deferred stock-based compensation of $36 million, amortization of purchased intangible assets of $60 million, gain on publicly traded equity securities of ($85) million, income tax effect of $5 million and cumulative effect of accounting change, net of tax, of $567 million.

Cisco Systems, Inc.
CONSOLIDATED BALANCE SHEETS
(In millions)
(Unaudited)
$ 37,107
May 1, 2004 July 26, 2003
ASSETS
Current assets:
Cash and cash equivalents $ 3,949 $ 3,925
Short-term investments 4,912 4,560
Accounts receivable, net of allowance for doubtful accounts of $188 at May 1, 2004 and $183 at July 26, 2003 1,540 1,351
Inventories 1,121 873
Deferred tax assets 1,905 1,975
Lease receivables, net 65 49
Prepaid expenses and other current assets 581 624
Total current assets 14,073 13,357
Investments 10,085 12,167
Property and equipment, net 3,351 3,643
Goodwill 4,198 4,043
Purchased intangible assets, net 387 556
Lease receivables, net 293 238
Other assets 2,810 3,103
TOTAL ASSETS $ 35,197

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
Accounts payable $ 604 $ 594
Income taxes payable 848 739
Accrued compensation 1,432 1,470
Deferred revenue 3,420 3,034
Other accrued liabilities 1,899 2,162
Restructuring liabilities 71 295
Total current liabilities 8,274 8,294
Deferred revenue 937 774
Total liabilities 9,211 9,068
Minority interest 5 10
Shareholders' equity 25,981 28,029
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 35,197 $ 37,107

Certain reclassifications have been made to prior year balances in order to conform to the current period's presentation.

Cisco Systems, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)
Nine Months Ended
May 1, 2004 April 26, 2003
Cash flows from operating activities:
Net income $ 3,021 $ 2,596
Adjustments to reconcile net income to net cash provided by operating activities:
Cumulative effect of accounting change, net of tax 567 -
Depreciation and amortization 1,133 1,166
Provision for doubtful accounts 19 -
Provision for inventory 124 26
Deferred income taxes 305 131
Tax benefits from employee stock option plans 454 19
In-process research and development 3 3
Net (gains) losses and impairment charges on investments (149) 523
Change in operating assets and liabilities:
Accounts receivable (203) (48)
Inventories (371) 89
Prepaid expenses and other current assets (13) (79)
Accounts payable 1 10
Income taxes payable 144 (319)
Accrued compensation (41) (72)
Deferred revenue 543 (133)
Other accrued liabilities (274) (203)
Restructuring liabilities (224) (18)
Net cash provided by operating activities 5,039 3,691
Cash flows from investing activities:
Purchases of short-term investments (10,008) (6,759)
Proceeds from sales and maturities of short-term investments 10,911 7,346
Purchases of investments (16,054) (13,024)
Proceeds from sales and maturities of investments 16,820 7,975
Acquisition of property and equipment (487) (504)
Acquisition of businesses, net of cash and cash equivalents (104) 3
Change in lease receivables, net (71) 49
Change in investments in privately held companies 20 (141)
Purchase of minority interest of Cisco Systems, K.K. (Japan) (71) (59)
Other 146 126
Net cash provided by (used) in investing activities 1,102 (4,988)
Cash flows from financing activities:
Issuance of common stock 930 279
Repurchase of common stock (7,082) (4,549)
Other 35 23
Net cash used in financing activities (6,117) (4,247)
Net increase (decrease) in cash and cash equivalents 24 (5,544)
Cash and cash equivalents, beginning of period 3,925 9,484
Cash and cash equivalents, end of period $ 3,949 $ 3,940

Cisco Systems, Inc.
ADDITIONAL FINANCIAL INFORMATION
(In millions)
(Unaudited)
May 1, 2004 July 26, 2003
CASH AND CASH EQUIVALENTS AND TOTAL INVESTMENTS
Cash and cash equivalents $ 3,949 $ 3,925
Fixed income securities 14,043 15,982
Publicly traded equity securities 954 745
Total $ 18,946 $ 20,652
INVENTORIES
Raw materials $ 56 $ 38
Work in process 422 291
Finished goods 611 515
Demonstration systems 32 29
Total $ 1,121 $ 873
PROPERTY AND EQUIPMENT, NET
Land, buildings, and leasehold improvements $ 3,424 $ 3,411
Computer equipment and related software 1,224 1,147
Production, engineering, and other equipment 2,676 2,410
Operating lease assets 98 356
Furniture and fixtures 356 350
7,778 7,674
Less, accumulated depreciation and amortization (4,427) (4,031)
Total $ 3,351 $ 3,643
OTHER ASSETS
Deferred tax assets $ 1,316 $ 1,476
Investments in privately held companies 360 516
Income tax receivable 690 727
Structured loans, net 19 42
Other 425 342
Total $ 2,810 $ 3,103
DEFERRED REVENUE
Service $ 2,864 $ 2,451
Product 1,493 1,357
Total 4,357 3,808
Less, current portion (3,420) (3,034)
Non-current deferred revenue $ 937 $ 774

This Q&A may be deemed to contain forward-looking statements, which are subject to the safe harbor provisions of the Private Litigation Reform Act of 1995. These forward-looking statements include, among other things, statements regarding new product releases, future events and the future financial performance of Cisco that involve risks and uncertainties. Readers are cautioned that these forward-looking statements are only predictions and may differ materially from actual future events or results due to a variety of factors, including: business and economic conditions and growth trends in the networking industry and in various geographic regions; global economic conditions and uncertainties in the geopolitical environment; overall information technology spending; the growth of the Internet and levels of capital spending on Internet-based systems; variations in customer demand for products and services, including sales to the service provider market; the timing of orders and manufacturing lead times; changes in customer order patterns or customer mix; insufficient, excess or obsolete inventory; variability of component costs; increased price competition; variations in sales channels, product costs or mix of products sold; the ability to successfully acquire businesses and technologies and to successfully integrate and operate these acquired businesses and technologies; increased competition in the networking industry; dependence on the introduction and market acceptance of new product offerings and standards; rapid technological and market change; manufacturing and sourcing risks; product defects and returns; litigation involving patents, intellectual property, antitrust, stockholder and other matters; the ability to recruit and retain key personnel; financial risk management; currency fluctuations and other international factors; potential volatility in operating results and other factors listed in Cisco's most recent reports on Form 10-K, 10-Q and 8-K. The financial information contained in this Q&A should be read in conjunction with the consolidated financial statements and notes thereto included in Cisco's most recent reports on Form 10-K and Form 10-Q, each as it may be amended from time to time. Cisco's results of operations for the three and nine months ended May 1, 2004 are not necessarily indicative of Cisco's operating results for any future periods. Any projections in this Q&A are based on limited information currently available to Cisco, which is subject to change. Although any such projections and the factors influencing them will likely change, Cisco will not necessarily update the information, since Cisco will only provide guidance at certain points during the year. Such information speaks only as of the date of this Q&A.

Cisco provides pro forma net income and pro forma net income per share data as additional information to help investors better understand its operating results. These measures are not in accordance with, or an alternative for, generally accepted accounting principles and may be different from pro forma measures used by other companies. Cisco believes that this presentation of pro forma net income and pro forma net income per share provides useful information to management and investors regarding certain additional financial and business trends relating to its financial condition and results of operations. Cisco believes when GAAP net income and GAAP net income per share is viewed in conjunction with pro forma net income and pro forma net income per share, investors are provided with a more meaningful understanding of Cisco's ongoing operating performance. In addition, Cisco's management uses these measures for reviewing the financial results of Cisco.

Copyright© 2004 Cisco Systems, Inc. All rights reserved. Cisco, Cisco Systems, the Cisco Systems logo, MGX and Linksys are registered trademarks or trademarks of Cisco Systems, Inc. and/or its affiliates in the U.S. and certain other countries. All other trademarks mentioned in this document or Website are the property of their respective owners. The use of the word partner does not imply a partnership relationship between Cisco and any other company.

 
***** document ****** # 437785 Cisco CEO John Chambers and CFO Dennis Powell Discuss Q3 Fiscal Year 2004 Results http://newsroom.cisco.com/dlls/2004/hd_051104b.html active

Y Tue May 11 22:20:00 GMT 2004 null

May 11, 2004

Cisco has announced its Q3, Fiscal Year 2004 financial results. John Chambers, president and CEO, and Dennis Powell, CFO and senior vice president, had the following to say regarding the company's results and business outlook.

How would you characterize this most recent quarter?

More Information

News Release
Cisco Systems Reports Third Quarter Earnings

Related Link
Customer Highlights and Technology Innovations Fact Sheet:Third Quarter, FY 04

Q&A: Dennis Powell On Cisco's Q3 Financial Position

You have set forth three long-term financial priorities, can you provide an update?

Dennis Powell: Cisco's results this quarter are reflective of our continued focus on our three long-term, key financial priorities. First, we continued to generate profitable growth, as evidenced by our increase in revenue of 22 percent year-over-year, and our pro forma profit increasing 26 percent year-over-year and representing 24 percent of revenue. Second, I am pleased with our progress to date on Cisco's productivity, as measured in terms of pro forma operating expense as a percentage of revenue, at 38 percent quarter to quarter. However, we remain committed to our longer term objective to achieve 35 percent of operating expense as a percentage of revenue. Finally we maintained our healthy and conservative balance sheet, and we continue to effectively manage our working capital, helped by our strong cash flow from operations.

GAAP net income increased 67 percent quarter-over-quarter, while pro forma net income was up only 3 percent--why such a large difference between the two?

Dennis Powell: GAAP net income was impacted in Q2FY04, due to an accounting charge related to the acquisition of Andiamo. The $567 million, non-cash variable stock compensation charge was taken at the end of Q2FY04. As a one-time charge, the charge from this accounting change was not included in our Q2 pro forma results, however it impacted Q2 GAAP earnings by $.08 per share, and accounts for a significant portion of the difference between Q3 and Q2 GAAP net income results. This is a good example of why we offer pro forma results as a supplemental measure to provide greater transparency to our financial results.

John Chambers: We are pleased to have achieved record earnings per share this quarter-marking our eighth consecutive quarter with pro forma net income exceeding $1 billion, and the strongest cash flow from operations in the company's history.

We were very pleased with almost all of our operational measurements for the quarter-with a good balance in terms of our focus on profit contribution, net income, gross margins, profitable market share gains, geographic balance, Advanced Technologies and revenue growth. We were pleased with our Q3 revenue results of $5.6 billion, a 4 percent sequential quarter-over-quarter increase and year-over-year product revenue growth of approximately 25 percent. This represents the fourth quarter in a row with a sequential revenue growth. We continue to believe we have uniquely positioned Cisco in the market as the recovery continues to gain momentum on a global basis.

Did you see momentum in your core technologies and Advanced Technology markets?

John Chambers: Our record-setting earnings per share and profits were achieved through sequential order growth across all major product categories and solid progress in our Advanced Technologies including the areas of security, wireless LAN and IP telephony. Order momentum continued to be very strong for our major routing and switching product categories, with year-over-year growth of approximately 80 percent and sequential growth of approximately 13 percent for Advanced Technologies. Additionally, we are beginning to see a very good balance between the enterprise, commercial and service provider market segments in terms of order growth both sequentially and year-over-year.

The top three areas that generated the most interest in our enterprise accounts are security, wireless and IP telephony. This quarter, security revenue rose sequentially in the mid teens and both wireless and IP telephony rose sequentially a little over 20 percent. In the IP telephony area we also shipped our 3 millionth phone. To put this in proper perspective, it took us over 30 months to ship our first million phones, it took approximately 13 months to ship our next million phones, and in the last eight months, we shipped our next million phones.

During this quarter, where did Cisco see geographic strengths?

John Chambers:We were very pleased with the growth that occurred in terms of orders in the US enterprise and commercial market segments. Order growth in these segments represented the first major growth, adjusted for normal seasonality, that we have seen in a very long time with a good balance across all verticals. CEO opinions continue to show increasing optimism toward the economy and toward their own industries and companies. Time will tell if this momentum continues, but we were obviously pleased with this quarter from a US enterprise/commercial perspective.

In EMEA, Cisco saw order growth in the low double digits. In terms of major operations, the UK led the way in terms of sequential order growth in the 20 percent plus range, followed by Northern Europe in the low double digits. There was also solid sequential growth in Germany in the high single digits, which was the best we've seen in terms of sequential growth in over two years.

Japan increased from 7 percent in Q2 to 8 percent of our business, and had very solid sequential order growth of approximately 20 percent. Asia Pacific, represented a 10 percent of our total bookings with a slowing of orders in China, Hong Kong, and Taiwan from a sequential perspective due primarily to seasonal factors, although year-over-year growth in these areas remains solid. We saw good sequential order growth in India and other parts of Asia. In Americas International, after two strong quarters of double digit growth, Q3 growth continued in the high single digits. Canada posted the best sequential order growth rate of the large countries in Americas International, in the high teens.

In the coming year, where do you intend to focus your partnership and investments and acquisition strategies?

John Chambers: In the next year, we expect we will be increasingly active in acquisitions and investments and we will continue to grow our investment in our partners. We've identified a number of existing and adjacent markets that offer strong growth opportunities for Cisco across the service provider, enterprise and consumer markets, that include voice, security and video. Our alliance activity will focus on increasing the adoption of our Advanced Technologies and driving our service provider alliances.

What is your acquisition strategy?

John Chambers: As Dan Scheinman, our senior vice president of Corporate Development said on today's call, Cisco's fundamental acquisition strategy remains unchanged, and we will continue to take strategic risks. First, the ability to integrate and link acquisitions with Cisco's internal innovation and deep customer knowledge allows us to create multiple generations of products and technology leadership, including LAN switching, telephony and security. Second, acquisitions can provide unique ways to support new business models. For example, Linksys allowed Cisco to quickly and successfully enter the consumer market, while supporting a significantly different business model. Finally, we acquire to augment and enhance our current Advanced Technology strategy which includes the following spaces, such as security and IP telephony.

Have your recent acquisitions been successful?

John Chambers:The acquisitions we've made over the past two-and-a-half years have grown at almost 60 percent within the last year, and we believe have solid potential for growth going forward. What has changed recently is that we are seeing high quality teams, at more favorable prices, and at a much stronger point in their development cycle. In all, we expect that we will be busy over the next 12 to 18 months focused on creating more value for Cisco shareholders.


Cisco Systems, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per-share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
May 1, 2004
April 26, 2003
May 1, 2004
April 26, 2003
NET SALES:
Product $ 4,730 $ 3,799 $ 13,543 $ 11,703
Service 890 819 2,576 2,473
Total net sales 5,620 4,618 16,119 14,176
COST OF SALES:
Product 1,452 1,086 4,193 3,467
Service 301 263 855 765
Total cost of sales 1,753 1,349 5,048 4,232
GROSS MARGIN 3,867 3,269 11,071 9,944
OPERATING EXPENSES:
Research and development 801 703 2,295 2,290
Sales and marketing 1,131 1,019 3,295 3,084
General and administrative 215 181 605 504
Payroll tax on stock option exercises 3 - 12 -
Amortization of deferred stock-based compensation 101 25 188 101
Amortization of purchased intangible assets 60 92 182 284
In-process research and development 2 3 3 3
Total operating expenses 2,313 2,023 6,580 6,266
OPERATING INCOME 1,554 1,246 4,491 3,678
Interest Income 127 161 388 514
Other income (loss), net 40 (26) 177 (552)
Interest and other income (loss), net 167 135 565 (38)
INCOME BEFORE PROVISION FOR INCOME TAXES AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE 1,721 1,381 5,056 3,640
Provision for income taxes 510 394 1,468 1,044
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE 1,211 987 3,588 2,596
Cumulative effect of accounting change, net of tax - - (567) -
NET INCOME $ 1,211 $ 987 $ 3,021 $ 2,596
Income per share before cumulative effect of accounting change:
Basic $ 0.18 $ 0.14 $ 0.52 $ 0.36
Diluted $ 0.17 $ 0.14 $ 0.51 $ 0.36
Net income per share:
Basic $ 0.18 $ 0.14 $ 0.44 $ 0.36
Diluted $ 0.17 $ 0.14 $ 0.43 $ 0.36
Shares used in per-share calculation:
Basic 6,816 7,062 6,872 7,165
Diluted 7,074 7,158 7,095 7,257


Cisco Systems, Inc.
PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per-share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
May 1, 2004 April 26, 2003 May 1, 2004 April 26, 2003
NET SALES:
Product $ 4,730 $ 3,799 $ 13,543 $ 11,703
Service 890 819 2,576 2,473
Total net sales 5,620 4,618 16,119 14,176
COST OF SALES:
Product 1,452 1,086 4,193 3,467
Service 301 263 855 765
Total cost of sales 1,753 1,349 5,048 4,232
GROSS MARGIN 3,867 3,269 11,071 9,944
OPERATING EXPENSES:
Research and development 801 703 2,295 2,290
Sales and marketing 1,131 1,019 3,295 3,084
General and administrative 215 181 605 504
Total operating expenses (a) (b) (c) (d) 2,147 1,903 6,195 5,878
OPERATING INCOME (a) (b) (c) (d) 1,720 1,366 4,876 4,066
Interest income 127 161 388 514
Other income (loss), net (e) 40 (26) 92 (140)
Interest and other income (loss), net (e) 167 135 480 374
INCOME BEFORE PROVISION FOR INCOME TAXES (a) (b) (c) (d) (e) 1,887 1,501 5,356 4,440
Provision for income taxes (f) 528 420 1,499 1,242
NET INCOME $ 1,359 $ 1,081 $ 3,857 $ 3,198
Net income per share:
Basic $ 0.20 $ 0.15 $ 0.56 $0.45
Diluted $ 0.19 $ 0.15 $ 0.54 $ 0.44
Shares used in per-share calculation:
Basic 6,816 7,062 6,872 7,165
Diluted 7,074 7,158 7,095 7,257
A reconciliation between net income on a GAAP basis and pro forma net income is as follows:
GAAP net income $ 1,211 $ 987 $ 3,021 $ 2,596
(a) In-process research and development 2 3 3 3
(b) Payroll tax on stock option exercises 3 - 12 -
(c) Amortization of deferred stock-based compensation 101 25 188 101
(d) Amortization of purchased intangible assets 60 92 182 284
(e) (Gain) loss on publicly traded equity securities - - (85) 412
(f) Income tax effect (18) (26) (31) (198)
(g) Cumulative effect of accounting change, net of tax - - 567 -
Pro forma net income $ 1,359 $ 1,081 $ 3,857 $ 3,198

For the three month period ended January 24, 2004, pro forma net income and pro forma net income per share excluded the following items: in-process research and development of $1 million, payroll tax on stock option exercises of $7 million, amortization of deferred stock-based compensation of $36 million, amortization of purchased intangible assets of $60 million, gain on publicly traded equity securities of ($85) million, income tax effect of $5 million and cumulative effect of accounting change, net of tax, of $567 million.

Cisco Systems, Inc.
CONSOLIDATED BALANCE SHEETS
(In millions)
(Unaudited)
$ 37,107
May 1, 2004 July 26, 2003
ASSETS
Current assets:
Cash and cash equivalents $ 3,949 $ 3,925
Short-term investments 4,912 4,560
Accounts receivable, net of allowance for doubtful accounts of $188 at May 1, 2004 and $183 at July 26, 2003 1,540 1,351
Inventories 1,121 873
Deferred tax assets 1,905 1,975
Lease receivables, net 65 49
Prepaid expenses and other current assets 581 624
Total current assets 14,073 13,357
Investments 10,085 12,167
Property and equipment, net 3,351 3,643
Goodwill 4,198 4,043
Purchased intangible assets, net 387 556
Lease receivables, net 293 238
Other assets 2,810 3,103
TOTAL ASSETS $ 35,197

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
Accounts payable $ 604 $ 594
Income taxes payable 848 739
Accrued compensation 1,432 1,470
Deferred revenue 3,420 3,034
Other accrued liabilities 1,899 2,162
Restructuring liabilities 71 295
Total current liabilities 8,274 8,294
Deferred revenue 937 774
Total liabilities 9,211 9,068
Minority interest 5 10
Shareholders' equity 25,981 28,029
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 35,197 $ 37,107

Certain reclassifications have been made to prior year balances in order to conform to the current period's presentation.

Cisco Systems, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)
Nine Months Ended
May 1, 2004 April 26, 2003
Cash flows from operating activities:
Net income $ 3,021 $ 2,596
Adjustments to reconcile net income to net cash provided by operating activities:
Cumulative effect of accounting change, net of tax 567 -
Depreciation and amortization 1,133 1,166
Provision for doubtful accounts 19 -
Provision for inventory 124 26
Deferred income taxes 305 131
Tax benefits from employee stock option plans 454 19
In-process research and development 3 3
Net (gains) losses and impairment charges on investments (149) 523
Change in operating assets and liabilities:
Accounts receivable (203) (48)
Inventories (371) 89
Prepaid expenses and other current assets (13) (79)
Accounts payable 1 10
Income taxes payable 144 (319)
Accrued compensation (41) (72)
Deferred revenue 543 (133)
Other accrued liabilities (274) (203)
Restructuring liabilities (224) (18)
Net cash provided by operating activities 5,039 3,691
Cash flows from investing activities:
Purchases of short-term investments (10,008) (6,759)
Proceeds from sales and maturities of short-term investments 10,911 7,346
Purchases of investments (16,054) (13,024)
Proceeds from sales and maturities of investments 16,820 7,975
Acquisition of property and equipment (487) (504)
Acquisition of businesses, net of cash and cash equivalents (104) 3
Change in lease receivables, net (71) 49
Change in investments in privately held companies 20 (141)
Purchase of minority interest of Cisco Systems, K.K. (Japan) (71) (59)
Other 146 126
Net cash provided by (used) in investing activities 1,102 (4,988)
Cash flows from financing activities:
Issuance of common stock 930 279
Repurchase of common stock (7,082) (4,549)
Other 35 23
Net cash used in financing activities (6,117) (4,247)
Net increase (decrease) in cash and cash equivalents 24 (5,544)
Cash and cash equivalents, beginning of period 3,925 9,484
Cash and cash equivalents, end of period $ 3,949 $ 3,940

Cisco Systems, Inc.
ADDITIONAL FINANCIAL INFORMATION
(In millions)
(Unaudited)
May 1, 2004 July 26, 2003
CASH AND CASH EQUIVALENTS AND TOTAL INVESTMENTS
Cash and cash equivalents $ 3,949 $ 3,925
Fixed income securities 14,043 15,982
Publicly traded equity securities 954 745
Total $ 18,946 $ 20,652
INVENTORIES
Raw materials $ 56 $ 38
Work in process 422 291
Finished goods 611 515
Demonstration systems 32 29
Total $ 1,121 $ 873
PROPERTY AND EQUIPMENT, NET
Land, buildings, and leasehold improvements $ 3,424 $ 3,411
Computer equipment and related software 1,224 1,147
Production, engineering, and other equipment 2,676 2,410
Operating lease assets 98 356
Furniture and fixtures 356 350
7,778 7,674
Less, accumulated depreciation and amortization (4,427) (4,031)
Total $ 3,351 $ 3,643
OTHER ASSETS
Deferred tax assets $ 1,316 $ 1,476
Investments in privately held companies 360 516
Income tax receivable 690 727
Structured loans, net 19 42
Other 425 342
Total $ 2,810 $ 3,103
DEFERRED REVENUE
Service $ 2,864 $ 2,451
Product 1,493 1,357
Total 4,357 3,808
Less, current portion (3,420) (3,034)
Non-current deferred revenue $ 937 $ 774

This Q&A may be deemed to contain forward-looking statements, which are subject to the safe harbor provisions of the Private Litigation Reform Act of 1995. These forward-looking statements include, among other things, statements regarding new product releases, future events and the future financial performance of Cisco that involve risks and uncertainties. Readers are cautioned that these forward-looking statements are only predictions and may differ materially from actual future events or results due to a variety of factors, including: business and economic conditions and growth trends in the networking industry and in various geographic regions; global economic conditions and uncertainties in the geopolitical environment; overall information technology spending; the growth of the Internet and levels of capital spending on Internet-based systems; variations in customer demand for products and services, including sales to the service provider market; the timing of orders and manufacturing lead times; changes in customer order patterns or customer mix; insufficient, excess or obsolete inventory; variability of component costs; increased price competition; variations in sales channels, product costs or mix of products sold; the ability to successfully acquire businesses and technologies and to successfully integrate and operate these acquired businesses and technologies; increased competition in the networking industry; dependence on the introduction and market acceptance of new product offerings and standards; rapid technological and market change; manufacturing and sourcing risks; product defects and returns; litigation involving patents, intellectual property, antitrust, stockholder and other matters; the ability to recruit and retain key personnel; financial risk management; currency fluctuations and other international factors; potential volatility in operating results and other factors listed in Cisco's most recent reports on Form 10-K, 10-Q and 8-K. The financial information contained in this Q&A should be read in conjunction with the consolidated financial statements and notes thereto included in Cisco's most recent reports on Form 10-K and Form 10-Q, each as it may be amended from time to time. Cisco's results of operations for the three and nine months ended May 1, 2004 are not necessarily indicative of Cisco's operating results for any future periods. Any projections in this Q&A are based on limited information currently available to Cisco, which is subject to change. Although any such projections and the factors influencing them will likely change, Cisco will not necessarily update the information, since Cisco will only provide guidance at certain points during the year. Such information speaks only as of the date of this Q&A.

Cisco provides pro forma net income and pro forma net income per share data as additional information to help investors better understand its operating results. These measures are not in accordance with, or an alternative for, generally accepted accounting principles and may be different from pro forma measures used by other companies. Cisco believes that this presentation of pro forma net income and pro forma net income per share provides useful information to management and investors regarding certain additional financial and business trends relating to its financial condition and results of operations. Cisco believes when GAAP net income and GAAP net income per share is viewed in conjunction with pro forma net income and pro forma net income per share, investors are provided with a more meaningful understanding of Cisco's ongoing operating performance. In addition, Cisco's management uses these measures for reviewing the financial results of Cisco.

Copyright© 2004 Cisco Systems, Inc. All rights reserved. Cisco, Cisco Systems, the Cisco Systems logo, MGX and Linksys are registered trademarks or trademarks of Cisco Systems, Inc. and/or its affiliates in the U.S. and certain other countries. All other trademarks mentioned in this document or Website are the property of their respective owners. The use of the word partner does not imply a partnership relationship between Cisco and any other company.

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